RISK ASSESSMENT

Growth still driven by internal demand

Growth is set to remain firm in 2018, buoyed by private consumption and the recovery of investment. After falling due to a gap between two European programmes, public infrastructure investment will grow strongly thanks to the return of European funds in 2017. Private investment also is also expected to perform better, sustained by robust external demand for local products. Exports (more than 70% of GDP), of which 60% are directed to the European Union, will benefit from more dynamic eurozone growth and Russia’s exit from recession. Meanwhile, after the counter-sanctions and the Russian recession, substitute markets have been found for agri-food products, and for the road transport used for goods transit to Russia. Nevertheless, the contribution of external trade to growth will still be nil due to the simultaneous growth in imports associated with lively domestic demand. In addition, investment growth and rising industrial output will benefit construction.Private consumption will also support activity in 2018, buoyed by solid wage growth, lower taxes on households, and falling unemployment (7.4% in September 2017). Higher wages demonstrate the country’s declining population associated with the emigration of skilled workers, in part offset by greater resident worker participation brought about by the raise of the legal retirement age. However, higher consumption could be dampened by inflation, although at a more moderate pace in 2018.

Current account deficit and slight budget surplus

The position of the public accounts has improved considerably since 2009, when the deficit was in excess of 9%. In 2018, the fiscal balance should again be in positive territory. Higher tax receipts, linked to lively consumption and wage growth, should help offset the rise in defence spending, the index-linking of pensions, and the cuts to social security contributions all of which were implemented in 2017. The 2018 budget will focus on poverty reduction, by improving the health system and exonerating the lowest earners from tax obligations. The public debt burden (85% of which is held by non-residents and 37% of which is denominated in dollars) should gradually ease, especially as the structural balance (-0.1% forecast for 2017), adjusted for the influence of the economic cycle, has greatly improved since 2014.The trade deficit (5.5% of GDP in 2016) could edge upwards in 2018 thanks to robust internal demand, which local manufacturing output meets only in part. The service surplus generated by road transport will almost completely cover this. Dividend and interest repatriation by foreign investors (4.2% of GDP in 2016) will continue to exceed remittances by emigrant workers (2.9%). In these conditions, the current account balance is expected to worsen slightly, but will show only a modest deficit. European structural funds, accounting for an annual average of 3% of GDP, will continue to finance transport and energy infrastructure, research, and innovation. Foreign direct investments will still come mostly from northern Europe and will benefit a diverse variety of sectors.. The external debt burden (83% of GDP at the end of September 2017) is slowly shrinking as the banks reduce the debt (15% of total debt) they owe to their parent companies.

Government fragility is not expected to threaten the continuity of reforms

In the October 2016 elections, the electorate – irritated by corruption, the new labour code, and a lower standard of living than the European average – confounded expectations and voted in the centrist Farmers and Greens Union (LVZS), which won 56 out of 141 seats in the Seimas, the local parliament. Putting an end to the alternating coalitions led by the conservatives and social democrats, Saulius Skvernelis (LVZS) formed a coalition government with the Social Democratic Party (17 seats). However, in September 2017, the latter decided to leave the government coalition, although some ministers chose to remain in place. This departure could lead to early elections in 2018, even though this is not expected to fundamentally change the country’s policies, given the consensus within political circles on certain topics, such as the creation of a new social model aimed at reducing inequalities and poverty, and also convergence towards the other euro zone countries. Nevertheless, the many scandals linked to corruption among politicians will continue to cause distrust among the public. Moreover, the President Dalia Grybauskaitė is set to stick to her pro-European stance and firmness towards Russia because the country shares a border with the Russian enclave of Kalingrad – home to a major naval base. The Polish minority (7% of the population) will continue to be criticised because of its alleged collusion with Russia.